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Price Consulting

High-volume, high-visibility customers know they have negotiation power. That shouldn’t stop you from initiating price increases with them when they are warranted. Suppliers tend to back down under the pressure of negotiating with their biggest customers, and who can blame them? Rocking the boat on price issues sometimes puts your company at risk of losing the business.

But take heart: It is absolutely possible to raise prices, no matter how large your customer. This case study will show you how one specialty tool manufacturer’s strategy and tenacity earned them the price increase they truly deserved.

BACKGROUND

A manufacturer of specialty tools, 427 TOOL (alias), is about to initiate a price increase selectively applied across their business. Many accounts will see increases; the amounts will vary depending on the various levels of price sensitivity among items, customers and markets.

The customer, BIGWERKS (alias), is 427 TOOL’s third-largest customer, accounting for well over $2 million in sales. 427 TOOL has been serving BIGWERKS for over 15 years. The volumes are steady, but margins are diminishing. The last price increase accepted by BIGWERKS was in 2007. Since that time, 427 TOOL has attempted to execute price increases on two separate occasions with no success. BIGWERKS made the process grueling by intentionally prolonging any price increase discussions until 427 TOOL finally gave up.

Compounding matters is that the purchasing personnel within BIGWERKS seem to be constantly changing. Interruptions in relationships between sales representatives and buyers prevent any continuity in discussions, which has made it difficult to achieve price negotiation goals over extended periods of time. At this time, prices have remained unchanged for seven years and have now fallen below market pricing. Obviously, this has negatively impacted margins at this account for 427 TOOL. The 427 TOOL sales representative, Roger, is preparing for a long and drawn-out negotiation process.

THE PROCESS BEGINS

September 2013

Roger has scheduled a meeting with the buyer at BIGWERKS to present the price increase. The average increase amount is 3.5%. However, increases are applied selectively to individual items, and not all items will see an increase. Additionally, Roger has prepared a summary of rebates, trade show participations and other supporting services that 427 TOOL has delivered over the past several years to demonstrate the added value the company has provided to this important customer.

BIGWERKS buyer, Justin, listens attentively at first but quickly starts pushing back, challenging the rationale behind the increase. Additionally, he begins to paint a picture of growing opportunities for 427 TOOL in the future. Suggesting that larger opportunities lie ahead for the supplier is a common tactic used by buyers to move the discussion off of the increase. Many sales representatives react to this discussion; Roger does not. He knows the discussion is intended to divert attention away from the increase. He is committed to getting the increase and stays focused.

October 2013

BIGWERKS looks to solidify their position with 427 TOOL by offering a long-term supplier agreement. The agreement includes descriptions of promotions, rebates, trade show participation, warranty allowances and the like. There is no mention of the price increase in the agreement. 427 TOOL pushes back on signing the agreement, and BIGWERKS says that the agreement is not related to the pricing discussions. 427 TOOL signs the agreement but continues to push discussions on the price increase. Looking back, 427 TOOL admits they should have delayed the agreement until the price discussions were resolved. This minor setback, however, did not negatively affect the final outcome.

December 2013

Roger schedules another visit to discuss the price increase with BIGWERKS. At this time, the buyer asks for more supporting information to justify the increase. While they will provide information supporting cost increases of incoming materials, 427 TOOL’s policy is to not provide total cost information to customers. Roger delivers the cost increase information, and further discussions are delayed by BIGWERKS until the new year.

January 2014

Discussions start heating up. Roger is holding tight on the price negotiations. He continues to communicate with Justin to maintain momentum in communications and send the message that 427 TOOL is not retreating on this issue. It has been five months since negotiations began.

Justin shares a critical revelation in one of his telephone calls with Roger: He tells Roger that BIGWERKS really does not want to lose 427 TOOL as a supplier. This knowledge instills renewed confidence in Roger and spurs him to continue on his path.

Then Justin reveals a surprise. He states that BIGWERKS corporate has mandated price reductions from all suppliers in 2014. Is this a real mandate or just an attempt to offset the increase? Roger recognizes that BIGWERKS is trying either to thwart the increase completely and actually get a price decrease, or to use the mandate to negotiate a non-increase. Roger will not settle for either of these options. He and the management team at 427 TOOL are committed to getting the increase. (Management commitment is a key component to any price improvement initiative.)

Roger presses on relentlessly for the price increase. Intense discussions continue over a two-week period. Justin announces that the BIGWERKS division vice president will participate in the next telephone discussion. Roger decides to add to his own horsepower and invites 427 TOOL’s president to participate in this phone conference.

The conference call lasts nearly two hours. 427 TOOL holds their ground on the increase, not wavering from the initial amount. BIGWERKS makes no offer to counter and insists on no increase. Interestingly, BIGWERKS is fighting to protect its reputation on not accepting price increases. They believe that if word gets out to the supplier base that they accepted an increase, other suppliers will attempt increases as well. Their unwillingness to counter is also noted. They are desperately defending their reputation on no increases. At this point, it’s all or nothing.

Committed to the increase, 427 TOOL continues to hold their ground and insists on the increase in whole. Finally, after nearly two hours of negotiation, BIGWERKS accepts the full increase, with only one caveat: that the increase will go into effect in June so that BIGWERKS has time to get the new pricing into their systems. 427 TOOL is happy to oblige.

WHAT JUST HAPPENED?

In a word, commitment. Sometimes it takes fortitude to get what you want in pricing negotiations. 427 TOOL hadn’t been successful in executing a price increase at BIGWERKS in seven years. This time, the supplier committed to getting the increase and showed the tenacity to not back down. BIGWERKS, based on prior experiences, believed that 427 TOOL would eventually give up. When they didn’t, the tone was set for a new pricing relationship between the two companies.

The commitment to executing price increases at large accounts can be significant. Below is a summary of time and resources that 427 TOOL incurred during the process:

Number of meetings or telcons Approximately 12

Time commitment Estimated 40 man-hours

Amount of increase $90,000

Time to create pricing schedule 5 hours

Return on time invested $2,250 per hour

As Roger pointed out during our interview, the price increase goes straight to 427 TOOL’s bottom line. Other than sales commissions, the increase has no other costs extracted.

Each customer and each negotiation is different. In this case, reinforcing 427 TOOL’s position on the price increase was effective. Other situations may call for different strategies. Holding the line on increases, however, is a proven approach. It takes some courage and fortitude to execute, and it may mean bringing senior-level managers into the fray, but in the long run, it sets the groundwork for a more profitable long-term relationship.

So you have a price increase initiative coming up, and maybe you are a little anxious about writing a letter to your customers announcing it. That’s understandable. After all, you don’t write these announcements every day. Price increases occur only occasionally and, like strategic planning, it’s hard to master something without routine practice.

There are a variety of reasons for a price increase. Some increases are driven by rising material costs, restricted industry capacity or increases in demand. It’s fairly easy to communicate these changes because you can blame external sources for necessitating price hikes. But what about instances when you realize that a customer is paying less than fair market prices, and you want to capture those incremental dollars?

There may be a variety of reasons why some customers are not paying market prices – for instance, one-time discounts that became institutionalized, end-of-year price incentives to meet sales goals, or maybe prices were just set too low from the onset. How do you talk to customers about adjusting these prices up?

Talk to them about value. Look inside your company at active programs that are designed to deliver value to your customers. More than 90% of all activity in most companies can be tied to delivering value to the marketplace. Yet 90% of most companies don’t communicate that value to their customer base. Now is the time to speak up!

For example, consider new initiatives that might include a new CRM system to improve customer relationships and communication or a new manufacturing system that will improve delivery. And, how about added customer service personnel or field sales reps? Any of these programs deliver additional value to your customers.

Our research on buyers over the years has consistently revealed one theme that buyers rarely discuss: Buyers want to do business with suppliers that are profitable. Unprofitable suppliers are a potential risk to customers, and no buyer wants to be surprised and find themselves shopping for another supplier in an untimely manner.

Increased value and financial strength are valid arguments for increasing prices. Below is an actual price increase announcement for one of our clients. See if you can identify these themes throughout this letter.

Dear Mr. Smith:

ACME Corporation is constantly striving to better serve our customers with the best products and the best service in the market. We are currently managing several initiatives that will make it easier and more efficient for you to do business with us.

ACME is currently implementing a state-of-the-art Customer Relationship Management (CRM) program. This program will improve our communications with your company, provide you with information and data to better manage your processing systems, expedite service and ordering, and strengthen our overall relationship with our valued customers. In the end, your company will spend less time managing a vendor and more time managing the issues that are most important to you.

ACME is now a member of the Global Healthcare Exchange, an electronic Internet exchange that enables you to place orders with any vendor from a single location. This electronic solution saves you time in ordering and makes it easy to do business with ACME.

Additionally, we have invested more in our spare parts inventory to insure that we always have the components available for your equipment when you need them. We expanded our biomed training programs to train technicians to repair and service equipment on-site. And, we added more people to the technical and clinical hotline to assist you with troubleshooting and service.

These efforts have resulted in improved customer service that is being applauded by the industry. The National Group, a customer service research firm for the healthcare and high-tech markets, has awarded ACME with its prestigious Future Supplier Award for excellence in customer satisfaction for each of the past three years.

We are pleased to provide exceptional products and service, and will continue to invest in programs that create the benchmark for performance and satisfaction. In order to continue providing the highest-quality products and services, we are instituting a 2.7% price increase on some products effective May 1, 2015. These changes will insure that ACME continues to provide the highest-quality products in the industry backed by the best service for years to come.

We look forward to continuing our partnership with your firm and providing the service that has made ACME the industry leader. You will be contacted by an ACME representative in the coming days to answer any questions that you may have regarding our prices, service and products. In the meantime, if you have any questions or needs that require immediate assistance, feel free to contact your sales representative or our customer service department.

Sincerely,

Taking time to create thoughtful price increase announcements can go a long way to improving increase outcomes. You likely have more to talk about than you may realize. Start with a brief brainstorming session to identify all of the possible programs that deliver value to customers and let these be the basis for writing an effective price increase announcement.

Does your industry have a clear pricing leader? That is, does one firm tend to make price moves and industry participants follow?

If you are lucky, your industry works this way. If you are a price leader you may already know the benefits of this role. You can set the pace for price increases in your industry or at least have a strong influence. You can also influence the amount of the increase by leading. Smart competitors that follow will take your lead both on the timing and the amount. There is a clear advantage, and an industry responsibility, to being the price leader.

If you are a price follower, you too have responsibility within the industry. For example, supporting the price leaders moves both in the amount and timeframe is important. Our pricing consultants have seen many cases where the leader increases prices and a follower fails to make a timely move. The key is being timely. We have seen many price leaders roll back price increases because followers were “asleep at the switch” and didn’t increase prices in a timely manner. Timely can mean announcing increases within a couple of weeks to a month.

Be aware of your competitors pricing moves. But, above all, don’t engage in any discussion with competitors on anything related to pricing. Price discussions among competitors in the U.S. are illegal.

We were recently approached by two companies looking to identify the prices of their competitors. Each of these companies were manufacturing firms that produced made-to-order products. One was a forging company and the other a plastic injection molding company.

Management of these firms believed that if they knew the hourly rates of their competitors they would be able to price more competitively in the marketplace. While competitive pricing has some value our pricing consultants see too many companies basing their entire pricing approach on what their competitors are charging.

We see several problems with this approach.

First, you are assuming that the competitors pricing strategies are appropriate and effective in the marketplace. Don’t bet on it. We see very few companies that can execute a consistent and effective pricing strategy that captures the value truly deserved by the supplier. Cost plus and competitive match strategies are the norm in manufacturing environments and neither match price to value delivered. The result is money left on the table or sales that go unrealized due to overpricing.

Second, although a company may employ a certain pricing approach we see most firms varying from the approach on a regular basis. For instance, take the injection molding company who may target $35 per hour but will drop its rate to $26 or $28 per hour when capacity is down. How will you know when your competitor is willing to settle for a lower price? If you, in turn, target $35 to match your competitor and your competitor drops to $26 per hour you will surely be overpriced.

And consider that firms may become more aggressive on lower prices at the end of months, quarters or years when trying to achieve sales targets. We typically see wide variations in pricing at these times making the competitor appear erratic in their pricing approach.

Instead of gauging your prices to competitors focus on the economic value that your company delivers and price according to value. There should be a fair trade between the benefits that you deliver and the price that is paid.

The vast majority of sales programs do not have incentives focused on rewarding price performance. There are certainly plans that include incentives based on margins but not specifically on price.

So, first, why do we want to reward sales teams on price performance? If your sales team is currently involved in the pricing process through actually setting prices or discounting then you may want to consider a reward for performance achievement.

The key is to isolate price in the equation. Sales teams generally have the ability to impact sales unit volume as it is a key aspect of the job. They may also have pricing influence or control. What they don’t have is the ability to control margins. They have the ability to impact margins but not control them because the generally don’t have access to controlling costs.

We are then left with sales unit volume and price performance. Let’s look at a situation where the sales team is currently being compensated on profit margin attainment. How do we move towards a price performance incentive?

One approach is to minimize the disruption in compensation while adding the price component. In our scenario the reps are paid 28% commission on profit margin. Simply adding a price performance feature to this plan may not be sufficient to get the reps attention. Instead, consider reducing the profit margin commission to 25.2% (a 10% drop) and adding a price performance feature that brings the commission back to the original 28% mark.

The rep will lose no compensation when they achieve the margin and price performance goals. The key is to set price performance goals for each rep that provides a target where the 28% profit margin commission is realized.

Migrating toward a price performance incentive will minimize disruption and send a strong message that price management is an important aspect on the front lines.

Managers have an enormous number of measurements at their disposal to help them keep their finger on the pulse of business performance. Think of all the financial ratios and reports that are applied to nearly every aspect of a business operation. There are reports that measure sales, gross margin, operating profit, receivables, payables, quality, production efficiency and more.

But one critical report ­– the price performance report – is often missing. Yet pricing has more potential impact on profitability than any other profit driver. According to research by McKinsey & Company, a 1% improvement in price boosts net income by 11% for the average U.S. corporation. That means an additional $1 million to the bottom line for every $100 million in revenue.

So why are so few firms measuring their price performance? Wouldn’t it help to know whether your pricing is contributing positively or negatively to your profit margins? For many wholesale distributors and manufacturers, pricing can be dynamic, with prices varying for an item on a transaction-by-transaction basis. How do you know if your collective prices are increasing, holding or declining? And how are changes in pricing impacting your profit margins?

Price performance at the highest level is the change in overall price levels across a business. It measures the change in price on a percentage basis. For example, a business with a price performance improvement of 1.5% has seen prices increase overall by this amount and has contributed positively to profit margins. On the other side, a business with price performance of -1.25% has seen prices decline by this amount and has detracted from profit margins.

Measuring price performance is relatively easy, although it takes transactional-level data to execute. Measurement is simply defining the change in price across a time period multiplied by the number of units sold:

Price Performance = (Current Price – Previous Price) x Units Sold

The solution to this equation is the overall change in price-driven revenue. This equation is applied to each item sold in a given time period and summed to arrive at the total business impact.

Take the $100 million company that experiences a -1.5% price performance over a one-year period. Price was responsible for detracting from margin performance by $1.5 million. Margins may still have grown through cost reductions or increased sales, but price did not contribute to the gain.

The old saying “What gets measured gets managed” applies here. If you knew how your pricing was contributing to your financial performance, how would that change the way you manage your prices?

With insight into price performance, you begin to see where you are performing well and where there is room for improvement. What if you knew which items, markets, customers or sales reps were contributing positively to price performance and which ones were detracting from it? With measurements that provide visibility, you can manage more effectively and drive more margin to the bottom line.

Is price performance on your radar screen? If you are like most companies, your pricing management efforts fall short of a strategic pricing process in that they are limited to periodic analyses of historical practices and pricing events. A more proactive approach to strengthening your pricing performance includes data analysis, pricing policies and implementation, among other elements. And while analyses and supportive policies are pivotal, the key to realizing true pricing improvement rests on your implementation team – namely, your sales force.

Think of it this way. Building a successful pricing program without a strong implementation program is like building a car without wheels. It may have a lot of potential, but it won’t go anywhere.

Include a price performance requirement in the sales job description. Communicate to the sales team that pricing performance management at the point of sale is important. This won’t change pricing culture all by itself, but it will help set the tone for pricing expectations going forward.

Set price performance goals for each sales rep. Like sales goals, each rep should have a price performance target. For instance, reduce discounting by 1% in the next year.

Measure and track sales team price performance. Monthly reports that provide visibility to actual achievement versus price performance goals set the stage for managing pricing at the sales team level.

Conduct individual price performance reviews. Sit down with each rep and review their price performance each month or quarter. Discuss the challenges and opportunities for price improvement and create monthly plans for reaching goals.

Add a price performance feature to the compensation plan. Nothing gets a good rep’s attention like incentives and rewards. Create a specific pricing incentive that rewards price performance and goal achievement.

These five actions help send the message that each sales rep is expected to play an active role in upholding the company’s pricing policies and goals. This may feel like a foreign concept to your team at first, but, over time, it will become a natural part of your organization’s sales culture.

Consider training your sales team, too, on pricing execution and its impact on company financial performance. Every effort you make toward engaging your sales team in your strategic pricing process takes you a step closer to excellence in managing pricing performance.

When was that last time you increased your prices? Many wholesale distributors and manufacturing companies make it an annual event and create a pricing culture within the industry to expect timely increases. But for some companies, the time between price increases is just too long.

Take for example, the specialty chemical manufacturing company that waited 10 years to increase prices for one of its largest accounts. By the time the increase was applied costs had risen significantly enough to reduce margins to negative levels in some cases. The overall profit level of the account suffered and became a drain to the bottom line.

But, perhaps, even more damaging was the expectation created on the customer’s part that price increases just weren’t part of doing business with this supplier. In essence, the manufacturer taught the customer that price increases just didn’t happen. And, the customer firmly pushed back when the supplier finally executed an increase.

Buyers know which suppliers will increase prices and which ones don’t. They know which ones to push back on and which ones they need to accept. You can determine which list your company will reside by the frequency of price increases and the regularity.

For many wholesale distributors and manufacturing companies the accepted means of communicating prices is often through published price lists. Price lists allow the buyer a quick reference for prices and discount schedules. Many buyers have come to expect price lists from suppliers in certain industries like packaging and shipping supplies.

Our pricing consultants find that the challenge in using published price lists is that it locks your prices in place across a variety of different customers. These customers may not be similar in their respective price sensitivity. In order to appeal to the wide array of buyers it requires that we set a price which appeals to all. The result is a low price and reduced margins.

The alternative is to segment your customers based on price sensitivity and set prices for each segment. Making your pricing more granular creates opportunities for increased margins and higher sales close rates. Think of it as customizing your pricing for different situations.

The challenge lies in moving away from published price lists and towards a pricing segmentation model. In some cases, a more segmented model can be implemented through targeted price lists. But, more often it requires installation in the order entry system to manage the large number of new prices. Many companies have continued to provide product catalogs but refer customers to on-line pricing schedules.

When manufacturing companies and wholesale distributors are faced with increasing prices they often lose ground when buyers push back on the new pricing. Of course, buyers are well trained to roadblock any attempts to increase prices from suppliers. In fact, buyers invest 15 times more in technology to help them manage the prices they pay compared to the investment made by sellers to better manage the prices they charge for their goods and services.

While there are a number of negotiation strategies that can be employed by sellers, why not just say “No” when a buyer tries to negotiate downward? Our pricing consultants see sales reps cave on price negotiations on a regular basis when a simple “No” often sidelines the discussion. You have the right to defend your prices. Why not put up the ultimate response as a starting point?

You can later drop back to less forceful approaches like deferring increases or trading value for the increase. Our pricing experts are often surprised how frequently the buyer will back down on their position. After all, they are trained to push back and most often they get a response in their favor. Many don’t know what to do when the seller begins to actually negotiate.